Inflation Basics: What, Why, Where, How, Etc.

APM Inflation Basics

Inflation is the increase in the general price of goods and services. As it rises, every dollar in your wallet/purse/man bag/imagination buys you less. For example, if the annual rate of inflation is 2%, then in a year’s time a $1 widget will cost $1.02, on average. Australia’s inflation is measured by the quarterly Consumer Price Index, often just referred to as the CPI. To get this data, the Australian Bureau of Statistics measures price rises in a ‘basket’ of typical goods and services, stuff like milk, butter, clothes, education and beer/dusty WA red.

The Reserve Bank tries to keep inflation at 2% to 3% and, although to less effect more recently, achieves this using interest rates. This is called monetary policy and works thusly: higher interest rates means people have less discretionary income to spend on stuff because so many of us have a mortgage. Higher rates also crimp business borrowing and therefore business investment. This all combines to slow economic activity, which slows inflation.

There are two types of inflation …

Cost-push inflation: When taxes, wages and import prices go up so does the cost of making things. To maintain their profits, companies pass on these costs in the form of prices rises.

Demand-pull inflation: If the demand for typical goods and services is growing faster than the supply of those goods and services, prices increase as per the timeless laws of supply and demand. This often occurs in developing economies that have an emerging aspirational class without the resources and industries to supply that class with goods and services.

Other things to know …

Deflation: This is the opposite of inflation, i.e., prices are falling and inflation is below 1%.

Disinflation: People often confuse disinflation with deflation because they think disinflation sounds like the opposite of inflation. BUT IT’S NOT! Disinflation is just the slowing down of inflation, i.e., prices aren’t rising as fast as they were.

Stagflation: This is a particularly nasty phenomenon where you have rising unemployment and rising inflation. In other words, prices are going up but the economy is going down. It’s a bugger to fight because the normal method of raising interest rates doesn’t help (you just further slow an already tanking economy). The term was coined during the inflationary period of the 1970s, when recessed growth combined with the oil shock. It was a global problem back then, and some reckon it sealed the fate of the Whitlam government.

Class dismissed!